Your Home Buying Source

Monday, June 19, 2006

Credit 101 - Part 2 (Truths and Myths)

Credit Score Truths & MythsNearly every time I run someone’s credit, I get askedquestions like “will running my credit HURT my creditscore? or “How can I fix my credit?”

Your credit score is the single biggest factor ingetting a new home loan. If your score is above 720,you can possibly qualify for a $1 million home withvery little money down. If you score is below 500 andyou have $1 million in the bank, you may have troublequalifying for this exact same home. Your interest ratewill certainly be different.

Credit Scores are central to the loan process.

Nearly every lender uses them. The better your credit,the lower the risk to the bank, the lower your interestrate. Most lenders use your FICO score to determinewhether or not you qualify for a home. It’s such animportant issue that you and your clients should understandthe basics of the credit reporting system and themany myths surrounding it.

Credit scores give lenders a fast, objective andimpartial snapshot of a person’s credit risk basedon their credit history. That’s why lenders use FICOcredit scores when making credit decisions. Thehigher the individual’s score, the lower the risk to lenderswhen extending new credit to that person. It’s fast,easy and usually effective.

WHAT IS A GOOD CREDIT SCORE?Credit scores generally range from the mid-300's to a perfectscore of 850. The following will give you a general ideaof what your score tells lenders, but remember there areno set rules. Different products and lenders use differentguidelines for what is an acceptable score. Also, there willusually be differences in the scores calculated by each ofthe three credit bureaus. As stated, lenders will often usethe middle of your three scores.

720+ Excellent credit. You should have noproblems as most loan programs will beavailable to you.

680 - 719 Good credit. You should have fewproblems depending on what product youseek.

620 - 679 Lender has to take a closer look at your filebut should be able to qualify you for a loan.Some products may not be available.

570 - 619Higher risk; you will not be eligible for thebest rates and products. Products will belimited.

Below 570 Very high risk. Products will be limited andother factors will need to be considered.

The average person in the U.S. has a credit score around675. As you can see on the list above, the averageborrower's file needs a "closer look" and is not a"slam-dunk."

HOW DOES MY SCORE AFFECT MY INTEREST RATE?The better your score, the lower the risk to the lender, thelower your interest rate. Let's say that John Doe is buyinga new house for $300,000. He is employed, can documenthis income through his tax returns, and has enough fundsverified in the bank to put 20% down on the purchase ofhis new $300,000 home. He wants a 30-year fixed mortgage.Below you will find an example of how Mr. Doe'sinterest rate may fluctuate based on his credit score.

This is a primary example of why when you ask yourlender, "what is the rate today?" the answer is not simpleunless they know the credit score and financial profile ofthe borrower. Rates change based primarily on creditscores, use (owner-occupied vs. investment), incomedocumentation, down payment, and availability of funds.

Factors NOT Considered in Credit Scores. Age. Race. Gender. Religion. National origin. Receipt of public assistance. Inquiries made by companies forpromotional or account monitoringpurposes (credit card companies,where you have accounts, often runyour credit to make sure yoursituation has not dramatically changed)

WHAT FACTORS MAKE UP MY SCORE?Some of the factors considered in credit scores:Past problems:

• Delinquency

• Recent or serious derogatory public record orcollection

• Past due balances

• Limited information

• Account payment or credit history not longenough

• Lack of recent information on accounts

• Insufficient number of satisfactory accounts

• Date of last credit too recent

• Too few or no recent balances on revolvingaccounts (e.g. credit cards)

If you do all your shopping around in a short period, andit is focused on just getting a new home loan, then theanswer is "no", Credit inquiries are a negative factor indetermining credit scores. That's because statisticalstudies show that multiple inquiries are associated withhigh risk of default. Distressed borrowers often contactmany lenders hoping to find one who will approve them.

Multiple inquiries can also result from applicants shoppingfor the best deal. The credit bureaus understandthis and do not penalize you for it. Credit scorers usuallyignore inquiries, from a same industry, that occur within30 days of a score date.

Suppose I shopped a lender on May 30, for example,and the lender has my credit scored that day. Even if Ihad shopped 50 other lenders in May and they had allchecked my credit, none of those inquiries would affectmy credit score on May 30. Now, if you are also shoppingfor a new car, a new big screen TV, and applyingfor new credit cards during this same period, yes, thatwill create negativity on your credit report.

Remember, this score is assessing the "risk" in giving you a newloan. If you are contacting may different types of lendersfor many different products, you are giving the appearanceof extending your credit our further and thatmakes you more risky. You may also damage yourcredit if you spread your shopping over many months.

Circumstances can cause a consumer to shop, drop outof the market, and return later when conditions are morefavorable. You minimize the adverse effect by concentratingeach shopping episode to as short a window aspossible.

WILL CLOSING SOME OF MY ACCOUNTS HELP MYCREDIT SCORE?

Usually not. Closing accounts will not usually help yourcredit score, and may actually hurt it. Too many openaccounts can hurt your score. But once you've openedthe accounts, you've done the damage. You can't repairit by shutting the account, and you may actually makethings worse. The credit score looks at the differencebetween your available credit and what you're using.

Shut down accounts, and your total available creditshrinks, making your balances loom larger, which typicallyhurts your score. The score also tracks the lengthof your credit history. Shutting older accounts can alsomake your credit history look younger than it actually is,which can hurt your score. Rather than closing accounts,pay down your credit card debt. That's somethingthat actually can and usually will improve yourscore. If you must close accounts, transfer the balancesfrom newer accounts to older ones and close the onesyou have opened most recently.

HOW OFTEN DOES MY SCORE CHANGE?Your credit report is continually updated with new informationfrom your creditors. The FICO score is calculatedbased on the latest snapshot of information containedin your credit report at the time the score is requested.

Your FICO score from a month ago is probablynot the same score a lender would get from the consumerreporting agency today. Fluctuations of a fewpoints from month to month are quite common.

IF MY CREDIT REPORT HAS SOMETHING WRONGON IT, WHAT CAN I DO?The first thing you must do is get a copy of your report.For the best and quickest response, get a copy ofyour report from each of the three major bureaus. Theeasiest and most effective way is to request thisonline. Each of the bureaus will charge you a small feebut you will get online access and better responsetimes. Here is the contact information for each:

Once you get your report, review it very carefully. Ifthere is an item on your credit report that you feel is inaccurate,and there likely will be, you should challengeit. Details on how to challenge will be sent you withyour credit report. The credit bureau is required to begininvestigating the issue within 5 business days.

They are held to this action by an Act of Congress andthey will move fast. They will contact the creditor onyour behalf. You can also contact the creditor yourselfbut be prepared to experience complete and utterfrustration at its highest level. Do not only contact thecreditor. The bureau is absolutely your best bet!

Within about 30 days, you should have an answer toyour complaint. If, at that time, the original grantor ofcredit has not responded to the disputed item, it will beremoved from your credit report. However, if the creditorresponds and challenges your claims, you may havemore work to do.

I COMPLETELY PAID OFF ALL OF MY DEBT,WHY IS IT STILL ON MY CREDIT REPORT?A credit report shows your entire credit history, includingpaid off debts. Judgments and liens will remain inyour history for up to 10 years. A bankruptcy may stayon your credit report for 10 years as well.

Just because you paid it off, does not mean it did notexist. If you look at this report as the financial story ofyour life, this existed and although it is now paid, it tellsa story about a time when the debt, for whatever reason,went without being paid.

If you were late on your MasterCard five times in sixyears, just because you paid it off does not mean it isnow a positive reflection on your credit report vs. thenegative reflection it was before, which some peopleautomatically assume. It simply shows that you werelate at times but then paid it off. Don't expect a hugeincrease in your score as a result of this action. Keep inmind, the score is based on your credit history , not justhow you are today.

HOW CAN I IMPROVE MY SCORE?• Pay your bills on time. Late payments and collectionscan have a serious impact on your score.

• Keep balances low on credit cards. Do not "maxout"your cards. Most experts say keeping yourbalances below 60% is the most effective. For example,if you have a Visa with a limit of $2000, it isbest to keep the balance at $1200 or less.

• Limit your credit accounts to what you really need.Accounts that are no longer needed should be formallycancelled since zero balance accounts canstill count against you. However, remember, if youare closing accounts, transfer the balances to theoldest accounts and cancel the newer ones.

• Do not apply for credit frequently. Having a largenumber of inquiries on your credit report can worsenyour score.

• Check that your credit report information is accurate.

• Be conservative in applying for credit and makesure that your credit is only checked when necessary.

• If you have limited credit, obtain additionalcredit. Not having sufficient credit can negativelyimpact your score.

HOW LONG DOES IT TAKE TOSEE MY SCORES GO UP?It is possible for people whohave aggressively correctedtheir reports, to raise their scoresas much as 50 to 75 points inless than 60 days, but don’tcount on that. Your credit scoreis based on your history and thatcannot be corrected overnight.Review your report, correct it,and then, if you really careabout keeping it clean, pay yourbills on time, don't over extendyourself and don't max your cards out.

There is rarely enough time in the period between theday you make an offer until the day you close to correctyour credit report in such a manner that will make a substantialdifference in your score. Planning ahead canresult in cleaning your report, raising your score, andsaving you $10,000's in interest through the years.

Thursday, June 15, 2006

"Credit 101" - PART 1

ABOUT YOUR FICO SCOREThink about your credit report as a story about yourfinancial life, as told through your credit history. Thishas nothing to do with you personally. Everything isthere from the first credit card you got out of highschool to your cell phones to your most recent mortgage.It all has a very telling payment history. Someof it is good and some of it maybe not-so-good. Regardless,it tells a lender what he needs to know aboutyou. It tells the lender how committed you have beenhistorically, to paying your bills, both big and small, ontime. It simply tells us how risky it is to loan youmoney.A FICO score is a credit score developed by Fair Isaac & Co.Credit scoring. It is a method of determining the likelihood thatcredit users will pay their bills. It helps lenders determine the“risk” in granting you a loan. This method has become widelyaccepted by lenders as a reliable means of credit evaluation. Acredit score attempts to condense a borrower’s credit historyinto a single number. Fair, Isaac & Co. and the credit bureausdo not reveal how these scores are computed and The FederalTrade Commission has ruled this to be acceptable.Credit scores measure the likelihood of default, so creditscores are generated using factors that have been found topredict credit risk. These factors are not weighted evenly andseveral minor instances may indicate a higher risk than onemajor, but isolated, credit problem.

There are five main categories of credit information which impact your credit score:

1. Late payments, delinquencies, bankruptcies: Pastinability to pay on time will hurt your chances of getting creditin thefuture. More recent problems will be counted more heavilythan those in the past.

2. Outstanding debt: The more debt one has, the greater therisk that he or she will not be able to keep up with the payments

3. Length of credit history: With a short track record it isharder for a lender to assess creditworthiness

4. New applications for credit (inquiries): Frequent creditchecks by lenders may indicate that a borrower is lookingto increase his or her amount of debt.

5. Types of credit in use: Some types of credit, includingcredit cards, provide you with a credit line greater than theamount you have already borrowed. The more credit available,the greater the risk to the lender since a borrowercan easily increase their outstanding debt.

There are really three FICO scores computed by data providedby each of the three major bureaus--Experian, Trans Unionand Equifax. Most lenders use the middle of these threescores. For example, if Experian gave you a 689, Trans Union704, and Equifax 696, we would throw out the top score (TransUnion 704), throw out the bottom score (Experian 689) and usethe middle score of 696 from Equifax. Your FICO score for thepurposes of our loan would be 696.

The bureaus don't all share the same data and thus all havedifferent scores. One bureau may list more accounts for youthan another, for example, and the differences (in types of accounts,payment histories, credit limits and balances) will bereflected in the score that bureau computes for you.Because of those differences, it makes sense to pull and examine yourcredit reports from all three bureaus before you apply for amortgage. Fixing errors in all three reports before you shop fora loan is smart.

In the 2nd part of our series on "Credit Scores,"we will discuss "Credit Score Myths."Stay tuned, as Monday I will be continuing this series!

Feel free to contact me with any questions or to inquire about how to get a free copy of your credit report!